Cost of Performance vs. Market Based Approach

Government contractors use various resources to perform contracts and accomplish their work in different states. For multi-state contractors, service revenue is generally traced to a particular state based on one of the two approaches, “market-based” or “cost of performance.”

Cost of Performance

Many states continue to follow Cost of Performance (COP) sourcing rules for apportioning sales of services to a particular state. The cost of performance method is well-defined in Section 17 under the Uniform Division of Income for Tax Purposes Act (UDITPA). Sales of service are sourced in a particular state if the income producing activity is:

• performed in that state or
• performed both in and outside that state and a greater proportion of the activity is performed in this state than in any other state, based on costs of performance.

As an example, if an income producing activity involves three states (State A, State B, & State C) and State A has 40% of the costs and State B and State C have 30% of the costs each, State A will include 100% of the service revenue in its apportionment since that state has the greatest cost of performance compared to State B and State C.

Market Based

More and more states are moving from the traditional cost-of-performance method and adopting market-based sourcing rules to apportion sales of services. Under a market-based approach, receipt of sales is assigned to the state in which the services or benefits of the services are received or where the customer or marketplace is located. For example, a service was performed in State A, and the customer is in State B. If State A is a cost of performance state, the sale would be sourced to State A. If state B is a market-based sourcing state, the sale would also be sourced to State B.

Government contractors should analyze revenue on a contract-by-contract basis to make this determination. For illustration, if a business is located in Virginia (COB state) and performs a project for a client in Maryland (market based state). 100% of contract revenue should be allocated to both states, because the benefits of the services were received by Maryland, but all of the work was done in Virginia.